This post was written by Lorraine M. Campos and Gunjan R. Talati.

Investment firms and small technology companies should be aware of a rule recently proposed by the U.S. Small Business Administration (SBA) that may impact small business participation in two programs. The Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) Programs create funding opportunities for innovative small business concerns. The amendments in the proposed rule, which was issued May 15, 2012, relate to the programs’ eligibility standards. If the proposed rule is adopted, the pool of program participants would increase to include businesses that are majority-owned by multiple domestic venture capital operating companies (VCOCs), private equity firms or hedge funds. Prior to the proposed rule, small businesses that wanted to participate in the SBIR and STTR programs often could not obtain funding from VCOCs, private equity firms or hedge funds because such funding could impact the small business’ ability to remain “small” by the programs’ definition.

Some of the proposed changes warrant a closer look by companies owned by such investment firms or investment firms buying a portfolio company that benefits (or might benefit) from participation in these programs. To be eligible for program participation, an SBIR and STTR applicant must have 500 or fewer employees and be:

  • More than 50 percent owned and controlled by U.S. citizens, permanent resident aliens, or domestic business concerns (the proposed definition of domestic business concern is explained above); or
  • Majority-owned by multiple domestic VCOCs, hedge funds or private equity firms.

In addition, an applicant’s business affiliations may count toward the size determination, depending on the degree of control one business exercises over another. Thus, the number of employees in the affiliated businesses would count toward the size determination. While the SBA has identified eight situations where it may find affiliation, it has also carved an exception for investment firms that are minority investors in an SBIR/STTR applicant. However, that exception does not apply if:

  • The venture capital operating company, hedge fund, or private equity firm owns a majority of the portfolio company; or
  • The venture capital operating company, hedge fund, or private equity firm holds a majority of the seats of the board of directors of the portfolio company.

Comments to the amendments in the proposed rule can be submitted on or before July 16, 2012.